Hello, Foolin' Fools. Two weeks ago, in a devilish mood, I wrote that I wanted to short something. I said that I would avoid shorting: 1) "open" situations with high-growth potential, or 2) shorting solely on the basis of valuation. I'd look instead for companies: 1) in a "closed" situation, i.e., mature industries with little high-growth potential; 2) with a high debt-to-cash ratio; and 3) that have jumped the shark.
Jumping the shark is a reference to Happy Days, when Fonzie jumped a penned-in shark at the beginning of the fifth season. The "Jump the Shark" website argues that a keen observer would have realized then that Happy Days would never again be as good as it had been -- it would be all downhill from then on.
Those were my three criteria. Jeff Fischer and David Gardner use other criteria to find potential shorts -- "Buzzard Bait," as they call 'em. These criteria include: 1) average daily dollar volume and float limits, so that we won't have trouble buying back a short; 2) minimum share price of $7; 3) relative strength below 10; and 4) lower current assets than current liabilities and long-term debt -- that is:
current assets --------------------- < 1 (current liabilities + long-term debt)
Jeff and I ran a screen for companies that met the "Buzzard Bait" criteria. Ten stocks turned up at that time. The list contained a number of notable former high-flyers: Teligent (Nasdaq: TGNT), PSINet (Nasdaq: PSIX), and Viatel (Nasdaq: VYTL), all of which have fallen about 90% from their highs. There were even some names familiar to regular Rule Breaker readers: priceline.com (Nasdaq: PCLN) and Lernout & Hauspie (Nasdaq: LHSP) made the list, with USInternetworking (Nasdaq: USIX) not far behind. (Lernout and USIX were discussed in Break Down August, and Jeff reviewed priceline in September. If you know how to turn the latter around, enter our Save priceline contest!)
It occurred to me recently to run another familiar stock through the screen. It turned out that it met -- and comfortably exceeded -- all of the criteria. The final nail came with the precipitous drop in the stock this week, which pushed the relative strength below the desired level.
That stock: Amazon.com (Nasdaq: AMZN).
Its trading volume and sizable float easily qualify, as does its share price of about $21. Its relative strength just went below 10 on Tuesday. Its current assets as of June 30 were less than 46% (0.459) of current liabilities plus long-term debt -- and that number is surely lower now, after three more months of cash burning. (We'll know more when Amazon reports next Tuesday on its third quarter.) Its debt-to-cash, likewise, was 2.37 then and is certainly higher now.
That leaves the "closed" situation and shark jump criteria....
"Whoa!" the Foolish reader exclaims, "Youse guys own Amazon! How can you talk about shorting it?" You're right -- clever you. We're not about to sell the stock and we wouldn't short it until after we sold it, if we intended to at all. In my shorting article, however, I suggested that it might be easiest to spot a good short among your own holdings. It's they that you pay closest attention to. Spotting a shark jump isn't easy. If you can stay objective, you can recognize gross missteps that could do serious damage to the business.
Allow me, then, to play the devil's advocate and argue the case of the Market v. Amazon.com.
There was an interesting discussion on the Rule Breaker Strategies board about whether and when Amazon jumped the shark. Cal8 offered this thought-provoking opinion: "I think that AMZN jumped the shark when the stock appreciated too rapidly."
It may sound odd at first, but I think that there is something to it. Others have suggested that Amazon jumped the shark when it piled debt offering on debt offering, or when it expanded its business to include $2000 tri-fuel generators (thanks for that one, Buster). But, as Cal indicates, those things stemmed from the stock appreciation. As expectations grew, Amazon had to expand to meet them. It had to push its business forward at an overly rapid pace to satisfy the "land-grab" folks (many of them in the company itself).
It seemed like a good idea at the time. So what has changed? Well, it's turned out that those other businesses aren't making the mark that Amazon books and music did. They aren't adding to scale as much as anticipated and are far from profitable. Auctions and zShops haven't taken off.
Then there's the stock price. Normally, we'd say that the share price doesn't affect the underlying business. At Amazon, however, it certainly does. Partners such as Drugstore.com (Nasdaq: DSCM) have seen their shares fall substantially, hurting not only Amazon's balance sheet with equity losses but also its income statement, since the partners become unable to pay their dues for placement on Amazon. Living.com has already reduced Amazon's product offerings by one, when it went belly up and shut down the Home Living business.
Let's not forget Amazon itself. From public offerings to convertible bonds, it has built itself on its stock. It uses its stock as currency. When people lose faith in the foundation of a currency, it becomes worthless.
Amazon's stock is the Russian ruble of late 1998. People don't want to buy it, they don't want it in their portfolios. It won't be long before Amazon needs to raise some real currency to pay for its operations. When it does, unless the climate has changed radically (which, of course, it may), Amazon won't have easy or cheap access to the equity or bond markets.
These are constricting, not expanding, possibilities. The consumer market and the stock market are limiting Amazon's growth. There are some things it can do to ease the situation. It can make deals like the recent one with Toys "R" Us (NYSE: TOY). That deal protects Amazon from inventory perils in businesses it doesn't know as well as books and music.
Unfortunately, it also limits Amazon's profitability potential in those businesses. They become merely the fulfillment and shipping company. That's a "closed" situation. Furthermore, who is going to partner with Amazon to take the inventory risk on tri-fuel generators or table saws, or even weed whacker replacement spools (thanks again, Buster)?
Amazon's possibilities are drying up. Its expanded offerings are not catching on -- in fact, they're withering. Its partners are failing. The dream of being the Wal-Mart (NYSE: WMT) of the Internet is dying. It's debt-heavy and running through its cash, with little hope of getting financing at anything like a reasonable rate from the markets. As for its valuation, it's fallen a lot (to about $8 billion now), but that's a lot of room yet to drop.
Of course, I could be wrong. Amazon has a great, highly recognizable name. That's key on the Net. It may well stay in business and be one of the most successful e-commerce companies in the world. It has demonstrated vibrancy in the past and could again. It's far from a sure short. I think, however, we may have seen Jeff Bezos in his leather jacket skidding over a mechanical fish.
When did Amazon.com jump the shark?
a) Day One
b) When its stock appreciated wildly
c) When it issued too many convertible bonds
d) When it began offering tools and patio furniture
Finally, if the recent market mayhem and concomitant drop in the value of your IRA have you worried about your golden years, just enroll in our upcoming Retirement Seminar.
--Brian Lund, known to WWF fans as TMF Tardior. Any takers?